MSCI launches factor ESG index series

Oct 2nd, 2017 | By | Category: Equities

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MSCI has announced the launch of a new range of indices, the MSCI Factor ESG Target Index Series, designed to provide exposure to target factors while integrating environmental, social and governance (ESG) stock selection filters.

MSCI launches factor ESG index series

Diana Tidd, MSCI’s global head of index.

Diana Tidd, head of index at MSCI, commented: “MSCI is seen as a thought leader in ESG and factor investing, and this new suite of indexes helps our clients integrate ESG while still focusing on the benefits of Factor Investing. We work closely with our clients to bring index solutions to market.”

The move is the latest in a string of new indices that seek to combine smart beta and ESG screening, but the news from MSCI carries extra significance due to the firm’s prominence in the factor and ESG index space.

As of June 2017, the firm was the world’s largest ESG index provider by number of indices and assets tracking those indices, and there were $214 billion in assets benchmarked to MSCI’s factor indices.

Stuart Doole, global head of index new product development, MSCI, commented: “Institutional investors increasingly are moving toward integrating ESG criteria into their portfolios and their factor allocations, in particular. This shift is driven by their recognition of the financial relevance of ESG issues to their risk management and their focus on long-term sustainable investing.”

The methodology used in the MSCI Factor ESG Target indices aims to maximise the exposure to the target factor along with a 20% improvement in the ESG score of the factor index relative to its parent market-cap weighted index. Sector and country exposures are constrained to within +/-5% of the parent index’s exposures.

“The MSCI Factor ESG Target Indexes’ “one-step” optimization approach achieved significant improvement of the ESG profile of a single- or multi-factor index relative to its market-cap-weighted parent with modest or no negative impact on the indexes’ ability to capture factor return premia over the December 2007 to June 2017 study period,” said Doole.

Interestingly, the MSCI research also shows that including an ESG screen improved the risk-adjusted performance of the stand-alone factor indices, meaning investors can have their cake and eat it by investing responsibly and improving performance at the same time.

Doole added, “Incorporating ESG generally tilted the index constituents toward stocks with higher market capitalization, better earnings quality, improved earnings stability, lower financial leverage and lower residual volatility. The improvement in historical risk-adjusted performance may be attributed to these factor tilts and the improved ESG profile as well as to stock-specific sources of return.”

There are 16 indices in the suite at present, one of each of the above four factor exposures for US, Europe, Japanese and world equities.

The indices are suitable for replication via index-linked investment products and, with ESG and Factor investing both receiving much investor attention, they will likely appeal to product developers at ETF issuers.

Already there are numerous ETFs that track members of the MSCI Factor Index series. Of those domiciled and listed in Europe, the largest is the iShares Edge MSCI World Minimum Volatility UCITS ETF (LON: MINV) with $2.0 billion in assets under management. The index provider is also doing well in the ESG ETF space thanks to its partnership with UBS ETF in Europe and its SRI line-up of ETFs.

Combining the two in ETF format seems like a logical next move.

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